The world is full of aspiring real estate investors, and few get started. Of those that actually buy properties, more fail than not. If you are serious about investing in real estate, you must avoid the pitfalls and prepare for success. I’ve made many mistakes, but you can learn from my personal experience and incorporate the ten reasons real estate investors fail into your business model.
In this article, I will outline several reasons many first time investors use a failing investment strategy. I’ll explain why it’s a problem and give you some tips to sidestep it. Each of these reasons is important and warrants additional study beyond this article. You should learn each of these for the best results and prepare a path to avoid the problem entirely.
1) Paying Too Much For the Property
Paying too much for a property is the biggest reason that new real estate investors fail. Of course, no one wants to pay too much for a property, but many investors don’t know what they should pay. Sometimes, an investor is in a hurry to make a deal, so they overpay. Others will say I am a buy-and-hold investor, so I can pay more for a real estate investment; this is not the case.
The first step to avoid overpaying is to know what you should pay. Once you know this, you must stick to the numbers and never overpay for an investment property. If you are ever in doubt about what to pay, you should always err on the low side, even if that causes you to lose the deal. I have an article that will teach you precisely what you should pay for a rental house in all real estate markets.
2) Underestimating the Expenses
Whether buying a flip or investing in rental properties, investing in real estate comes with unexpected expenses. There are costs to buy the property, such as a title search, filing, and attorney fees. There are loan costs, like an origination fee and mortgage interest. After you get the property, you have renovation expenses, property taxes, and holding costs. For rental real estate investors, you will have maintenance issues and tenant damage; if it’s a flip house, you will have fees when selling the property.
Before making a deal, you must understand all the costs associated with investment property. Don’t skimp when it comes to due diligence. Make sure you know what everything will cost, and when you aren’t sure, estimate on the high side. As for rentals, I have an article showing you how to determine operating expenses with surprising accuracy.
3) Cherry Picking Comps
Cherry-picking comps means using select comparables that make the deal work while ignoring others. This happens when you determine value by looking at the highest comps and weeding out anything low or average. For a rental, this would be estimating the likely rent by only looking at other properties with high rents. There is nothing wrong with aiming for a high selling price or rent, but you should base your deal on average numbers in local markets.
When looking for comps, the more you have, the better. You should exclude the extraordinarily high and low outliers and then take the average of the other comps. To be successful, you want to build a real estate portfolio based on the average numbers, and then higher numbers are a bonus.
4) Making Speculative Investments
A speculative investment is based on factors outside of your control. This happens when you buy a property that requires market appreciation to be a successful investment. Or one in which you expect rents to rise, making your losing investment a winner in the long run. In many cases, your speculation was incorrect, or it takes longer than expected, and you end up with a losing investment.
Speculative investing is gambling. When you invest, make decisions based on the facts, not predictions. Make a good investment, and don’t buy the wrong property with hope as your only plan. It’s always best to buy a property below the current market value and profit when nothing special happens.
5) Paying for Work Before it’s Finished
Most contractors are not crooks; they want to do an excellent job promptly and get follow on work. However, when you pay them in advance, they have that money locked in, so they chase the next job and are slow to get back to yours. Once you have paid for the work, you have no leverage to get the contractor back to the site. If you got a lousy contractor, holding back the last 10% or so isn’t enough incentive to get them to come back.
Never pay for the work upfront, but for big jobs, you can pay for material upfront. Remember you only pay for the materials, so go to home depot and swipe your card. I once paid for roofing materials upfront directly to the roofer, and I never saw him again. That was a $3,500 lesson. You can learn from me and never spend that much money on a lesson.
6) Doing the Wrong Renovations
Many smart investors fail because they do the wrong renovations. Usually, this entails making the property too nice for the neighborhood by doing things such as splurging on a fancy shower or adding granite countertops when surrounding houses don’t have these amenities. They often justify by saying it will set their home apart, causing it to sell faster and get them a higher price. However, these upgrades have a negligible effect on the appraisal, which is most often what sets the actual selling price of the house. Ultimately, it sells near the average, and the investor loses money.
This problem is not confined to flipping nicer houses. I have seen landlords do this with low-end properties that will be rented. This usually takes the form of renovating a home to a much nicer standard than the houses around it. Perhaps each room has fancy light fixtures, and they put down premium flooring and install top-shelf appliances. These higher costs put a dent in their cash flow, reducing their passive income, and after a tenant lives there for a year, it looks just like the neighboring houses.
7) They Don’t Know How to Run The Numbers
Running the numbers is essential to be a successful real estate investor, and skipping this step will often lead to failure. Knowing how to calculate ROI, Cash Flow, and other proven metrics is essential. These numbers provide a way to measure the success of your project and compare it with other potential investments. Failing to understand these numbers is one of the biggest reasons real estate investors fail.
It is more than just knowing how to calculate the numbers. You must understand what the metrics mean and what industry standards are for those metrics. As for the actual calculation, it’s always garbage-in, and garbage-out, so you must make accurate income and expense estimates. I’ve written an article that should show you how successful property owners run the numbers for a rental house.
8) Not Understanding the Leverage
The proper use of leverage, more commonly called a loan, will allow you to multiply your investment gains. However, improper use of leverage is one of the main reasons that send investors into foreclosure. You don’t want too much debt, but you don’t want to avoid it either.
Learning how to apply leverage best will prove to be valuable during your investing career. You should know what drives interest rates and stay abreast of the current rates in your sector. You are not always looking for the lowest payment, but debt service significantly impacts cash flow, so you must carefully consider it. The proper use of leverage can take your real estate investing to the next level.
9) Unrealistic Expectations
Often investors, especially new investors, will have unrealistic expectations. They see real estate investing as a get-rich-quick scheme and are disappointed when a successful project doesn’t provide the expected high returns. This will often cause investors to give up and not pursue other projects.
For rental property owners, it’s common for a first-time landlord to expect a large cash flow on their property. They see the fixed costs, such as property tax, insurance, and loan payment, but they fail to understand how much the expenses will be. They expect to make $800 per month, and when it’s a very reasonable $200, the frustration sets in, and soon, they have dumped the property at a loss.
Remember, large profits are common over the long hall but require hard work and delicate management of cash flow. Don’t rush it.
10) Paying Market Value
Paying market value is a sure way to lose money in most markets. Many investors are constantly running the numbers using the asking price on Zillow and trying to find acceptable deals. This rarely works; you must purchase deals at a significant discount to market value.
Finding properties that sell at a discount is the most difficult time a real estate investor with have. If this step were easy, everyone would be doing it. This is precisely why you need to get good at finding the right property. You must resist the urge to pay market value, or you will become a statistic for the reasons real estate investors fail.
There will be times when there are no deals, so don’t buy anything and wait for a good deal to come along. Don’t pay market value just to get a project going, thinking you will find a way to profit later; you won’t.
This article has given you ten reasons that real estate investors often fail, and all are within your control. Of course, things outside of your control can happen, but worrying about them is not good. Successful investors know how to avoid these common reasons that cause failure. In this article I explained how to mitigate the risk, and it’s not that difficult. Observing the number 1 rule in real estate investing, which is “never pay too much for an investment property,” is the best way to l lessen the impact of most mistakes and build a successful real estate business.